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LabCorp Buyout Needs Pre-Bust M&A Market (Update 1)

NEW YORK (
TheStreet) -- Clinical laboratory giant
LabCorp's (LH - Get Report) shares are up after a
Mergermarket report that it may become the target of a private equity buyout, in a consortium deal that would mirror the size and style of pre-bust leveraged takeovers.

Bank of America (BAC - Get Report) is reportedly working to arrange debt financing to fund the group buyout, which could involve private equity giants
TPG Capital and
Bain Capital, in addition to
KKR (KKR - Get Report) and
The Blackstone Group (BX - Get Report). Potential buyout participants could put in $3 billion to $4 billion apiece,
Mergermarket reports, citing unnamed sources.

LabCorp rebutted the notion that it is in talks about a buyout. "The company has no knowledge of any such plans and is not in current discussions with any firms to effect such a transaction," said LabCorp, in a statement. "Beyond that the company intends to maintain its policy of not commenting on market rumors or speculation," it added.

Although a horde of unused private equity cash augurs well for large buyouts, only a few recent deals have been transacted.
Apollo Group(APO) and KKR have recently used recovering debt markets to raise billions in leveraged buyout debt for energy sector takeovers of
El Paso's oil exploration unit and privately held exploration and production company
Samson, but debt-fueled consortium bids have been rare since the financial crisis.

A dearth of consortium buyouts makes the report of interest in a LabCorp notable because of the size of a potential deal and the established appetite of PE firms for deals across the health care sector: clinical research labs, medical devices and hospitals. A consortium bid funded by billions in new debt would mirror some of the larger pre-bust healthcare buyouts, like KKR's takeover of
HCA Holdings (HCA).

"[We] continue to believe that an LBO of either LabCorp or
Quest Diagnostics (DGX - Get Report) is financially plausible given high relative ratios of unlevered [free cash flow] generation to [enterprise value]," wrote Cigitroup analyst Gary Taylor, in a Wednesday note to clients. Taylor calculates that a takeover of LabCorp could reach $100 a share, putting a deal at an enterprise value of $12.5 billion. LabCorp's market cap was $8.5 billion.

In early Wednesday trading, LabCorp rose over to 3% to above $87, while Quest Diagnostics rose 1%, retreating on LabCorp's statement from pre-market action which sent shares higher by 13% and 5%, respectively.

Piper Jaffray analyst Kevin Ellich wrote in a note to clients that LabCorp could be worth "north of $100" in a potential leveraged buyout. According to calculations from Citigroup's Taylor, buyers would likely use roughly $4.6 billion of equity and $8 billion in debt financing to fund a deal. The necessary $8 billion in debt financing for a LabCorp buyout, "could test the limits of current LBO debt appetite," writes Taylor.

In fact, while the dearth of large-sized buyouts and consortium deals since the crisis makes the LabCorp report noteworthy, it also indicate reasons why the speculation should be viewed cautiously. Struggles to raise billions in buyout related debt have been reported to stall takeovers of companies like
Yahoo! (YHOO) and
Best Buy(BBY).

The key to a successful debt raise appears to be LabCorp's stable cash flow and its expected return on equity. The company is expected to generate nearly $800 million in free cash flow this year, allowing private equity buyers to pay down any acquisition-related debt, according to Citigroup's Taylor. Those cash flows would also be a hedge against weak earnings. "This level of free cash flow generation would allow the company to delever 0.7x annually even if EBITDA does not grow," wrote Taylor.

For more on healthcare related mergers and acquisitions, see why
WellPoint's (WLP) deal for
Amerigroup (AGP) is a
landmark transaction.